So it has finally happened, the S&P 500 hit 2000 and a bunch of female celebrities had naked pictures stolen from them and published on-line! Not hard to figure out which was a bigger event for most Americans. I wasn’t watching CNBC, but did they break out the baseball caps they bought way back in 2007 with “2000” written all over them? Anyway, it was a quieter week with lighter volume heading into the holiday weekend, but what does it matter? Equities and Treasuries both enjoyed one of their strongest months in 2014 leaving us to wonder, where do we go from here?
With a few exceptions, much of this week looked like an instant replay of the week before and you don’t need a line judge spending ten minutes under a hood to tell you that. After reaching 2000, the S&P 500 proceeded to test its new level and thus putting up small gains for the week as momentum scores returned to 2014 highs while those indices with more room to cover before hitting new highs managed to outperform for the week. The Russell 2000 remains stuck in a trading range with overhead resistance (using IWM) at around $118.50. If the week starts off on a positive note that could be a natural point for us to peter out while the most recent closing high was at $119.82. Still a good 2.8% away from where we’re at now.
Foreign stocks lagged broadly although several European specific ETF’s did better on the week despite the economic situation in Europe beginning to unravel in the face of growing unease over the direction of economic policy. Emerging markets also did well on the week although it seemed to bit hit and miss for those looking to play a country theme. Market Vectors Russia ETF (RSX) was down 4.13% on the week while the Brazil iShares (EWZ) was up 6.53%. Anyone want to play macro headlines? The Global X FTSE Argentina 20 ETF (ARGT) has pulled back to prior resistance. In Asia, the Japanese sell-off continued while Chinese ETFs continued to consolidate after a strong three months. MCHI continues to hold not far from its recent highs and above prior resistance, hopefully setting up for a strong advance soon.
For those brethren out there looking to do some sector rotation, the last shall be first blah blah blah. A few sectors continue to march to the beat of their own drummer but last week the action was chasing what hadn’t gone up the week before. Take a look.
Treasuries continued to dominate headlines devoted to the credit market as on-going tensions in Europe could be helping an on-going trend. I’m sure everyone has been playing “connect-the-dots” and trying to link Ukraine with the fall in Treasury yields, but the issues are much deeper than that. But in the meantime, check out the fat numbers being put up by long duration anything this year. Who says you can’t make money in bonds? Or at least make back what you lost in 2013.
Major releases from Eurostat this weekend confirmed much of the pessimism that Mario Draghi discussed at the recent Jackson Hole Summit. Eurozone inflation printed at .3%, a level not seen since October 2009 while Italy, mired in recession, printed a negative .2% as did Portugal, Spain, Greece and Slovenia. Unemployment remains stubbornly high at 11.5% while the Markit Manufacturing PMI fell to a 13 month low at 50.7. Couple this with the sacking of a mutinous French cabinet angered by the current economic policies, the upcoming Scottish independence vote and a small scare war, truly, not the best of times. No wonder the Euro is falling and stocks can’t catch a bid.
So what do you do, besides start planning an Italian vacation? Hypothetically speaking, if the Euro is weakening the dollar must be rallying, so why not buy U.S. dollar denominated assets and what’s safer than a Treasury bond? Or think about it this way, you could plow even more money into Bunds but if you’re worried about financial instability and a rise in short-term borrowing costs to frustrate your plans to lever that trade up, why bother? Why not take the easy way out, convert to dollars and plow it all into higher-yielding Treasuries? Yes in time the dollar should correct so that there’s no arbitrage possibilities available, but right now we’re in panic mode people. Put your head between your legs and brace yourself. Worry about the math later (that’s what they say anyway.)
But if you don’t want to listen to me, check out this nice chart below of the Powershares DB German Bund Futures ETN and then go read the literature on the Powershares website here. Leaving aside issues with ETN’s, it offers a nice and unlevered approach to gaining dollar denominated bund exposure and you can see that as the Euro began weakening in May, BUNL was off to the moon while a comparable U.S. Treasury ETF traded back and forth till the start of August.
This all could be adding fuel to the Treasury fire rather than being the crazy guy with mittens pinned to his chest who started the fire in the first place. Look at the weekly chart of the ten year Treasury yield. The down sloping line is the upper boundary of the downtrend line dating back to 2007 that had acted as resistance for Treasury yields over the last few years. After becoming deeply oversold in late 2013, the strong action has helped the ten year yield get back below the down trend line. How much longer can it continue?
If our pals at the Pension Partners blog are right, you have two strong trends pulling you in opposite directions. One side of the market favors equities, partly because rates are low and likely to stay that way for a prolonged period of time (love me the good ole fashioned Gordon growth model) helping support higher valuations not to mention that the economy in the U.S. is growing in the right direction. The other side favors bonds, feeling that the specter of global deflation will overwhelm pockets of economic growth which will soon falter when A.) QE3 ends, B.) The Russian tanks reach Paris C.) any day now. Just you wait. Me personally, who knows?
I still hold the opinion that Draghi, with sufficient support from Europe’s elected leaders, can pull of the start of an Abenomics program for Europe. The rise of resistance to the current means in France as well as within the Bundestag itself probably will motivate a few people, mostly because they fear voters will treat them the same way the Italian resistance treated Mussolini in 1945. From start to finish, their efforts have been misdirected with the Eurozone response to their fiscal crisis has seemed like a plan to keep the fiscal status quo with Germany and the Northern tier running massive current account surpluses while the Southern zone is forced to make cost adjustments to become more competitive through major lay-offs and deflation. I’m still of the opinion that a full recovery is on-hold unless a system to correct fiscal in-balances is put forth but until that happens, in Draghi we must trust.